Trujillo needs to step on the growth pedal

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QUEENSLAND Senator Barnaby Joyce will probably flip again and
back legislation clearing the way for a Telstra share sale after he
assures himself that funding of the $2 billion bush
telecommunications fund is secure.

But the chances of a sale actually occurring next year depend on
what Telstra chief executive Sol Trujillo has to say at the end of
next month, when he announces the results of his stocktake of the
company.

A political bushfire has engulfed the shares since Trujillo took
over, driving them down from around $5 to Friday's close of $4.35,
90¢ below the Government's notional sale price and more than
$3 below the last Telstra privatisation share sale in October
1999.

Trujillo and his executives poured petrol on the blaze by
claiming that the telco's financial condition is worse than
appreciated, and its future bleak under the current regulatory
regime. If they continue to push that line, there is little
prospect of there being sufficient investor demand in a year's time
to soak up the Government's 51.8 per cent, 6.4 billion share
stake.

But Trujillo has the opportunity next month to launch a fresh
strategic direction for Telstra that requires a new way of working
out what the company is worth.

In August 2003 Telstra's board, chaired by Bob Mansfield,
announced that Ziggy Switkowski had been reappointed as chief
executive until December 31, 2007, but the chairman and his chief
executive were both on borrowed time.

Mansfield resigned in April last year, two months after the
board had rejected a proposal he and Switkowski backed, to acquire
John Fairfax and merge Fairfax's classified advertising business
into Telstra's Sensis directory information business.

Switkowski survived, but in June the board announced a change in
strategy that signalled that his hand had been removed from the
tiller.

In comments that could have been made by Solomon Trujillo this
week, it said Telstra's copper wire land network was being
overtaken "by wireless, high bandwidth internet, and emerging
applications and content services."

Telstra was investing in the new services, and the
infrastructure needed to provide them, and would continue to keep
its balance sheet strong, the board said.

But it also promised to pay out around 80 per cent of its profit
in dividends, and to return another $1.5 billion to shareholders
each year for three years, through special dividends or share
buybacks.

The board made it clear this new policy meant that big takeovers
were off the menu. There would only be enough financial firepower
left after the capital return program for "well targeted
acquisitions of moderate scale", it said.

This suited the sharemarket. Telstra's expansion into mobile
telephony and wholesale data transmission in Asia had been a costly
failure, and pressure had been mounting on the group to be less
adventurous  and to run itself like toll roads, power
stations and other so-called utilities, for maximum cash generation
and maximum returns to shareholders. The commitment to pay $1.5
billion extra a year meant that Telstra would be paying out more
than the free cash it was generating for the limited life of the
program, but this was stated upfront, and hardly controversial,
because companies that redirect dependable cash flows back to
shareholders can afford to run relatively highly geared balance
sheets.

Overall, the new strategy was positively received. By the end of
March, the shares had risen by about 50¢ to a high of $5.49,
and with the Government in control of both houses of Parliament,
the T3 sale was looking likely.

Telstra's comment in a briefing paper handed to the Government
last month that its dividends were not being covered, would require
borrowings of over $2 billion this year, and were "not a
sustainable policy or practice" should not have created the
controversy that it did, given those facts. At some point the
entire strategy of maximising returns to shareholders was always
going to have to be reconsidered.

But Trujillo's appointment has dragged the timing of that
rethink forward.

The strategy that the board set out in June last year curtailed
Telstra's appetite for growth. Telstra shares became an investment
yield play, and the dividends they generated  40¢ in the
year to June just passed, made up of 28¢ in regular dividends
and two special 6¢ dividends  underpinned the share
price.

Telstra has not publicly abandoned the "walk like a
utility"strategy it adopted in June last year, but only one more
6¢ special dividend is assured, and Trujillo's body language
suggests that growth will be re-emphasised.

He argues that Telstra's growth is being stunted by rules that
compel it to sell access to its network to competitors at
unrealistically low prices, and Telstra itself has arguably been
guilty of self-harm, through its acquiescence to the regime. It
behaved defensively last year when it adopted the utility stance,
but Trujillo's unsuccessful attempt to interest the Government in a
jointly funded $5.7 billion national high-speed broadband rollout
shows that he is looking for ways to more aggressively attack the
domestic telco market and, in particular, for ways to deploy
infrastructure to replace the group's ageing copper network.

Telstra's cost base will fall under Trujillo's leadership. The
group is expected to rationalise its product line, and cut employee
numbers. The key to valuing the stock, however, will be not the
cuts Trujillo makes but his plans for growth, and the ways growth
can be funded.

As a defensive yield play, Telstra shares are worth about $4.50
at most on the basis of the ordinary 28¢ a share dividend.
That's the base, and it's barely enough to get the float away.

But if (and it's a big if) Trujillo can upgrade the group's
growth outlook as well, the shares will have a chance of rising
back towards $5 again  and the decidedly inferior option of
getting Telstra out from under Government control by parking the
51.8 per cent stake in Peter Costello's Future Fund might be
avoidable.